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Swiss Central Bank Acts to Put a Cap on Franc's Rise

PARIS — Alarmed by the threat a soaring currency poses to Switzerland’s economy, the country’s central bank sought Tuesday to cap the value of the franc against the euro and said it was prepared to spend an unlimited amount to defend it.

The Swiss currency, long considered a haven in crises, has surged against the euro and the dollar this year as investors have fled turmoil in the markets. That has raised fears among Swiss companies that the country’s exporters will be priced out of business abroad.

“The current massive overvaluation of the Swiss franc poses an acute threat to the Swiss economy and carries the risk of a deflationary development,” the Swiss National Bank said in a statement. It said it was “therefore aiming for a substantial and sustained weakening of the Swiss franc.”

The central bank “will no longer tolerate” an exchange rate below 1.20 francs to the euro, and “will enforce this minimum rate with the utmost determination and is prepared to buy foreign currency in unlimited quantities,” said the statement, which was unusual for its strong wording.

The franc fell sharply, with the euro rallying to 1.20527 Swiss francs in afternoon trading Tuesday in New York from 1.1201 francs late Friday. The dollar soared to 0.8624 Swiss franc from 0.7880 franc late Friday.

The central bank’s move underscores the particular challenges facing Switzerland amid global economic uncertainty. The bank’s chairman, Philipp M. Hildebrand, has been roundly criticized at home for the strength of the franc, though it is mainly a reflection of problems elsewhere.

Holger Schmieding, chief economist at Berenberg Bank in London, described the Swiss National Bank as “probably the best-run central bank in the Western world.” But with a “grossly overvalued currency,” Switzerland risks falling into a deflationary trap as imports become relatively cheaper, he wrote in a note.

Deflation, a generalized decline in prices, increases the burden on debtors and tends to paralyze an economy as consumers guard their money in anticipation of lower prices.

With doubts about the United States economy and as investors fear that European assets could lose much of their value if the euro currency union were to fail, Switzerland has been the unenthusiastic recipient of billions of dollars in investment inflows.

Photo

Philipp M. Hildebrand, chairman of the Swiss National Bank, in Bern, when the bank moved to contain the franc's rise, saying its overvaluation threatened the Swiss economy.Credit
Pool photo by Peter Schneider

On Aug. 9, the euro traded as low as 1.00749 francs — near parity — and the dollar fell as low as 0.7071 franc.

Another traditional haven — gold — reached a record of $1,923.70 an ounce in trading Tuesday of contracts for December delivery, before retreating below $1,900. But the price of oil has fallen because of the global slowdown, eliminating another place where investors might be tempted to put cash.

The market mayhem has also bolstered the yen, now trading near a record against the dollar, as Japanese investors unwind risky investments overseas.

Florian Esterer, a fund manager at Swisscanto Asset Management in Zurich, said Switzerland’s attraction resulted in part from its reputation for political stability and sound policy.

“The stable economic performance is a result of the institutional setup,” Mr. Esterer said.

One thing that is clear is what is good for investors is not necessarily good for Swiss business.

“At parity the franc is overvalued by 35 percent or more,” Rudolf Minsch, chief economist of Economiesuisse, a federation of Swiss business organizations, said. “It no longer has anything to do with fundamentals at that level.”

Mr. Minsch said the pain among his members was particularly severe in the tourism, textiles, machinery, metals and paper industries.

Switzerland’s biggest trading partner is the European Union, but the overvalued franc is also affecting business in the United States and the developing world, he said.

“In places like China, German companies have a cost advantage of as much as 30 percent,” he said.

Photo

A machine sorting Swiss franc notes at a bank in Zurich. The currency has surged against the euro and the dollar this year.Credit
Arnd Wiegmann/Reuters

This is not the first time the Swiss central bank has resorted to such a strategy to contain the franc. It used a similar operation in the late 1970s to weaken the currency against the Deutsche mark. The central bank’s new target commits it to buying euros and selling francs any time the euro falls below 1.20 francs. That amounts to setting a floor for the euro or a ceiling for the franc.

The authorities had considered adopting a currency peg, in which the franc would be defended at a specific rate. In reality, considering the downward pressure on the euro, the 1.20 franc level will probably prove a de facto peg for now.

Currency market intervention, when it is not coordinated among the major central banks, has not had a lasting effect in recent years, as the Bank of Japan learned recently. Last year, the Swiss bank’s unsuccessful efforts to check the franc’s rise with market intervention led it to a foreign exchange loss of 32.8 billion francs, or $41.6 billion at current exchange rates, and an overall loss for the year of 20.8 billion francs, or $26.4 billion.

Steven Saywell, head of global currency strategy in London for BNP Paribas, said he thought it “very unlikely” that the Swiss National Bank’s counterparts at the Federal Reserve and European Central Bank would be eager to follow suit in strengthening their currencies against the franc, even though a meeting Friday and Saturday of Group of 7 finance and central bank officials in Marseille, France, would give them a chance to coordinate policy.

“The G-7 has far greater issues to deal with,” Mr. Saywell said, “like preventing the U.S. economy from sliding into recession and supporting the ongoing political discussions about addressing Europe’s debt problems.”

In fact, the European Central Bank appeared to distance itself from the Swiss move, saying in a two-sentence statement that the Swiss central bank had decided to hold down the value of the franc “under its own responsibility.”

Mr. Saywell said investors were certain to test Switzerland’s resolve, as the authorities there were trying to buck a strong tide.

“In an environment of strong growth and economic stability, the franc might weaken,” he said. “But in this climate, we expect the market to challenge the S.N.B. over the next few days.”

Last month, as part of a continuing effort to weaken the franc, the Swiss National Bank cut its main interest rate target to zero from 0.25 percent and said it would significantly increase the supply of liquidity to the Swiss franc money market. It moved twice during the month to increase banks’ sight deposits through which banks can withdraw money, to 200 billion francs from 80 billion francs. It also said it would conduct foreign exchange swap transactions to create liquidity in Swiss francs.

Even at a rate of 1.20 francs per euro, the central bank said Tuesday, “the Swiss franc is still high and should continue to weaken over time.” It said that “If the economic outlook and deflationary risks so require, the S.N.B. will take further measures.”

A version of this article appears in print on September 7, 2011, on page B9 of the New York edition with the headline: Swiss Bank Moves to Cap Franc’s Value Against Euro. Order Reprints|Today's Paper|Subscribe